First Community Bankshares Inc: Form 10-Q for the period ended Jun 30, 2024

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand our financial condition, changes in financial condition, and results of operations. MD&A contains forward-looking statements and should be read in conjunction with our consolidated financial statements, accompanying notes, and other financial information included in this report and our Annual Report on Form 10-K for the year ended December 31, 2023 (the “2023 Form 10-K”). Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

Executive Overview

First Community Bankshares, Inc. (the “Company”) is a financial holding company, headquartered in Bluefield, Virginia, that provides banking products and services through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia chartered bank institution. As of June 30, 2024, the Bank operated 53 branches in Virginia, West Virginia, North Carolina and Tennessee. As of June 30, 2024, full-time equivalent employees, calculated using the number of hours worked, totaled 591. Our primary source of earnings is net interest income, the difference between interest earned on assets and interest paid on liabilities, which is supplemented by fees for services, commissions on sales, and various deposit service charges. We fund our lending and investing activities primarily through the retail deposit operations of our branch banking network. We invest our funds primarily in loans to retail and commercial customers and various investment securities. Our common stock is traded on the NASDAQ Global Select Market under the symbol FCBC.

The Bank offers trust management, estate administration, and investment advisory services through its Trust Division and wholly owned subsidiary First Community Wealth Management Inc. (“FCWM”). The Trust Division manages inter vivos trusts and trusts under will, develops and administers employee benefit and individual retirement plans, and manages and settles estates. Fiduciary fees for these services are charged on a schedule related to the size, nature, and complexity of the account. Revenues consist primarily of investment advisory fees and commissions on assets under management and administration. As of June 30, 2024, the Trust Division and FCWM managed and administered $1.58 billion in combined assets under various fee-based arrangements as fiduciary or agent. The Bank also offers a full range of commercial and personal insurance products through its strategic partnership with Bankers Insurance, LLC.

Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with generally accepted accounting principles (“GAAP”) in the U.S. and conform to general practices within the banking industry. Our financial position and results of operations may require management to make significant estimates and assumptions that have a material impact on our financial condition or operating performance. Due to the level of subjectivity and the susceptibility of such matters to change, actual results could differ significantly from management’s assumptions and estimates. Estimates, assumptions, and judgments, which are periodically evaluated, are based on historical experience and other factors, including expectations of future events believed reasonable under the circumstances. These estimates are generally necessary when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve, or when an asset or liability needs recorded based on the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices, when available, or third-party sources. When quoted prices or third-party information is not available, management estimates valuation adjustments primarily through the use of financial modeling techniques and appraisal estimates.

Our accounting policies are fundamental in understanding MD&A and the disclosures presented in Item 1, “Financial Statements,” of this Quarterly Report on Form 10-Q. Our accounting policies are described in detail in Note 1, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of our 2023 Form 10-K. Our critical accounting estimates are detailed in the “Critical Accounting Estimates” section in Part II, Item 7 of our 2023 Form 10-K.

Performance Overview

Highlights of our results of operations for the three and six months ended June 30, 2024, and financial condition as of June 30, 2024, include the following:

• Net income of $12.69 million for the second quarter of 2024, was an increase of $2.87 million, or 29.26%, from the same quarter of 2023. Net income of $25.53 million for the first six months of 2024, was an increase of $3.94 million, or 18.22%, from the same period of 2023.
• The provision for credit losses decreased $3.96 million, or 96.49%, from the same quarter of 2023. The second quarter of 2023 included $1.61 million of Day 2 provision associated with the Surrey Bancorp acquisition. The majority of the difference is due to a much smaller required credit loss provision as the loan portfolio has experienced a decline of $147.81 million from the same period of 2023. In addition, there was a recovery of provision for the allowance for unfunded commitments of $305 thousand for the current quarter; there was no provision for the same period of 2023.
• Net interest income decreased $950 thousand compared to the same quarter in 2023, primarily due to increases in rates paid on interest-bearing deposits.
• Net interest margin of 4.51% was an increase of 3 basis points over the same quarter of 2023. The yield on earning assets increased 45 basis points from the same period of 2023 and is attributable to an increase in interest income resulting from an increase in yield and an increase in average balance. There was an increase in yield for both loans and securities available for sale. The average balance for interest-bearing deposits with banks increased $147.11 million over the same period of 2023. The yield on interest-bearing liabilities increased 67 basis points when compared with the same period of 2023 and is primarily attributable to increased rates on interest-bearing deposit liabilities.
• Noninterest income increased approximately $557 thousand, or 6.34%, when compared to the same quarter of 2023. Noninterest expense increased $226 thousand, or 0.92%. Noninterest expense for the quarter ending June 30, 2024, included a non-recurring charge of $1.80 million to settle a putative class action lawsuit. Noninterest expense for the same period of 2023 included non-recurring expense of $2.01 million in merger charges related to the Surrey Bancorp acquisition.
• Annualized return on average assets was 1.58% for the second quarter and 1.59% for the first six months of 2024 compared to 1.18% and 1.36% for the same periods, respectively of 2023. Annualized return on average common equity was 10.02% for the second quarter and 10.10% for the first six months of 2024 compared to 8.04% and 9.48% for the same periods, respectively of 2023.
• Consolidated assets totaled $3.23 billion at June 30, 2024.
• Securities available-for-sale decreased $151.28 million, or 53.84%, from December 31, 2023. The decrease is primarily attributable to the maturity of $141.50 million in U.S. Treasury Notes during the first six months of 2024. Loans decreased $99.03 million, or 3.85%. Deposits decreased $45.05 million, or 1.65%. The net effect of these balance sheet changes resulted in an increase in cash and cash equivalents of $213.46 million, or 183.35%.
• The Company repurchased 155,044 common shares during the second quarter of 2024 at a total cost of $5.28 million. The Company repurchased 244,440 common shares during the first six months of 2024 at a total cost of $8.25 million.
• Non-performing loans to total loans increased slightly to 0.80% when compared with the same quarter of 2023. The Company experienced net charge-offs for the second quarter of 2024 of $1.03 million, or 0.16% of annualized average loans, compared to net charge-offs of $728 thousand, or 0.11%, of annualized average loans for the same period of 2023.
• The allowance for credit losses to total loans was 1.41% at June 30, 2024 compared to 1.41% at December 31, 2023, and 1.38% for June 30, 2023.
• Book value per share at June 30, 2024, was $27.85, an increase of $0.65 from year-end 2023.

Results of Operations

Net Income

The following table presents the changes in net income and related information for the periods indicated:

(Amounts in thousands, except per

Three-Month Comparison.

Net income increased $2.87 million in the second quarter of 2024 compared to the same period in 2023. The increase is primarily attributable to a decrease in provision for credit losses of $3.96 million. This increase was offset by a decrease in net interest income of $950 thousand compared to the same period in 2023.

Six-Month Comparison.

Net income increased $3.94 million in the first six months of 2024 compared to the same period in 2023. The increase is primarily attributable to a decrease in provision for credit losses of $4.69 million. In addition, net interest income increased $1.27 million and noninterest income increased $1.23 million. These increases were offset by an increase in noninterest expense of $2.80 million compared to the same period in 2023.

Net Interest Income

Net interest income, our largest contributor to earnings, is analyzed on a fully taxable equivalent (“FTE”) basis, a non-GAAP financial measure. For additional information, see “Non-GAAP Financial Measures” below. The following tables present the consolidated average balance sheets and net interest analysis on a FTE basis for the dates indicated:

AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS (Unaudited)

(Amounts in thousands)

(1) Interest income and average yield/rate are presented on a FTE, non-GAAP, basis using the federal statutory income tax rate of 21%.

(2) Nonaccrual loans are included in the average balance; however, no related interest income is recorded during the period of nonaccrual.

(3) Interest on loans includes non-cash and accelerated purchase accounting accretion of $661 thousand and $884 thousand for the three months ended June 30, 2024 and 2023, respectively.

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AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS (Unaudited)

(Amounts in thousands)

(1) Interest income and average yield/rate are presented on a FTE, non-GAAP, basis using the federal statutory income tax rate of 21%.

(2) Nonaccrual loans are included in the average balance; however, no related interest income is recorded during the period of nonaccrual.

(3) Interest on loans includes non-cash and accelerated purchase accounting accretion of $1.44 million and $1.08 million for the six months ended June 30, 2024 and 2023, respectively.

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The following table presents the impact to net interest income on an FTE basis due to changes in volume (change in average volume times the prior year’s average rate), rate (average rate times the prior year’s average volume), and rate/volume (average volume times the change in average rate), for the periods indicated:

(Amounts in thousands)

(1) FTE basis based on the federal statutory rate of 21%.

Three-Month Comparison. Net interest income comprised 77.35% of total net interest and noninterest income in the second quarter of 2024 compared to 78.91% in the same quarter of 2023. Net interest income on a GAAP basis decreased $950 thousand, or 2.89%. Net interest income on a FTE basis decreased $949 thousand, with a percentage decrease of 2.88%. The net interest margin on a FTE basis increased 3 basis points while the net interest spread on a FTE basis decreased 22 basis points. The increase in net interest margin was primarily driven by an increase in interest income on interest-bearing deposits with banks as well as an increase in interest income on loans. The increase in earnings on interest-bearing deposits with banks was primarily due to an increase in average balance of $147.11 million while the increase in loan interest is primarily due to an increase in yield of 28 basis points. The 22 basis point decrease in net interest spread is primarily due to the increase in yield for interest-bearing liabilities of 67 basis points versus the increase in yield for earning assets of 45 basis points.

Average earning assets decreased $97.66 million, or 3.31%, primarily due to an decrease in average securities available for sale of $173.51 million, or 54.52%. In addition, the average balance for loans decreased $71.27 million, or 2.77%. These decreases to earning assets were offset by an increase in the average balance for interest-bearing balances with banks of $147.11 million, or 232.32%. The yield on earning assets increased 45 basis points, or 9.47%, primarily due to an increase in benchmark rates as compared to the same period of 2023. The average loan to deposit ratio increased to 93.60% from 91.92% reported in the same quarter of 2023. Non-cash accretion income was $661 thousand for the second quarter compared to $884 thousand reported in the same period of 2023.

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $77.69 million, or 4.17%, primarily due to a decrease in deposits. Demand deposits decreased $48.24 million, or 6.77%, while time deposits decreased $35.94 million, or 12.73%. These decreases were offset by an increase in savings deposits of $13.11 million, or 1.52%. The yield on interest-bearing liabilities increased 67 basis points and is primarily due to increases in benchmark rates throughout 2023.

Six-Month Comparison. Net interest income comprised 77.36% of total net interest and noninterest income for the six months ending June 30, 2024 compared to 78.19% in the same period of 2023. Net interest income on a GAAP basis increased $1.27 million, or 2.03%. Net interest income on a FTE basis increased $1.27 million as well, with a percentage increase of 2.04%. The net interest margin on a FTE basis increased 7 basis points while the net interest spread on a FTE basis decreased 20 basis points. The increase in net interest margin was primarily driven by increase in the average balance for loans as well as an increase in the yield on loans. The average balance for loans increased $41.55 million, while the yield increased 43 basis points resulting in a tax effected increase in interest on loans of $6.58 million compared to 2023. The 20 basis point decrease in net interest spread is primarily due to the increase in yield for interest-bearing liabilities of 73 basis points versus the increase in yield for earning assets of 53 basis points.

Average earning assets increased $2.17 million, or 0.08%, primarily due to an increase in the average balance for interest-bearing deposits with banks of $86.24 million, or 165.15%, and an increase in the average balance of loans of $41.55 million, or 1.67%. These increases were offset by a decrease in the average balance for securities available for sale of $125.62 million, or 39.57% The yield on earning assets increased 53 basis points, or 11.47%, primarily due to an increase in benchmark rates as compared to the same period of 2023. The average loan to deposit ratio increased to 94.56% from 91.94% reported in the same period of 2023. Non-cash accretion income increased to $1.44 million from $1.08 million reported in the same period of 2023.

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $32.24 million, or 1.77%, primarily due to a decrease in deposits. Time deposits decreased $28.62 million, or 10.34%, while interest-bearing demand deposits decreased $24.53 million, or 3.56%. These decreases were offset by an increase in savings deposits of $25.79 million, or 3.05%. The yield on interest-bearing liabilities increased 73 basis points and is primarily due to increases in benchmark rates throughout 2023.

Provision for Credit Losses

Three-Month Comparison. The provision charged to operations decreased $3.96 million in the second quarter of 2024 compared to the same quarter of 2023. Provision for credit losses for loans of $449 thousand was recorded in the second quarter of 2024 compared to the provision of $4.11 million recorded in the same period of 2023. The provision of $4.11 million recorded in the second quarter of 2023 included $1.61 million of Day 2 provision associated with the Surrey Bancorp acquisition. The remaining decrease in provision is primarily due a much smaller required credit loss provision as the loan portfolio has experienced a decrease in balance of $147.81 million from the same period of 2023. In addition, there was a recovery of provision recorded for the allowance for unfunded commitments during the second quarter of 2024 of $305 thousand. There was no provision for the allowance for unfunded commitments for the same quarter of 2023.

Six-Month Comparison. The provision charged to operations decreased $4.69 million for the six months ending June 30, 2024 compared to the same period of 2023. Provision for credit losses for loans of $1.46 million was recorded in the first six months of 2024 compared to the provision of $6.08 million recorded in the same period of 2023. The provision of $6.08 million recorded in the first six months of 2023 included $1.61 million of Day 2 provision associated with the Surrey Bancorp acquisition. The remaining decrease in provision is primarily due a much smaller required credit loss provision as the loan portfolio has experienced a decrease in balance of $147.81 million from the same period of 2023. In addition, there was a recovery of provision recorded for the allowance for unfunded commitments during the first six months of 2024 of $305 thousand. There was a recovery of provision for the allowance for unfunded commitments for the same period of 2023 of $232 thousand.

Noninterest Income

The following table presents the components of, and changes in, noninterest income for the periods indicated:

(Amounts in thousands)

Three-Month Comparison. Noninterest income comprised 22.65% of total net interest and noninterest income in the second quarter of 2024 compared to 21.09% in the same quarter of 2023. Noninterest income increased $557 thousand or 6.34%. Other service charges and fees increased $210 thousand and was primarily driven by an increase in interchange income. Other operating income increased $263 thousand and is primarily attributable to a holdback payment of $184 thousand related to a prior divestiture of an insurance agency .

Six-Month Comparison. Noninterest income comprised 22.64% of total net interest and noninterest income for the six months ending June 30, 2024 compared to 21.81% in the same period of 2023. Noninterest income increased $1.23 million or 7.10%. Other service charges and fees increased 578 thousand and was primarily driven by an increase in interchange income. Other operating income increased $345 thousand and is primarily attributable to a holdback payment of $184 thousand related to a prior divestiture of an insurance agency.

Noninterest Expense

The following table presents the components of, and changes in, noninterest expense for the periods indicated:

(Amounts in thousands)

Three-Month Comparison. Noninterest expense increased $226 thousand, or 0.92%, in the second quarter of 2024 compared to the same quarter of 2023. Noninterest expense for the second quarter of 2024 included a non-recurring charge of $1.80 million recorded to settle a putative class action lawsuit. Noninterest expense for the same period of 2023 included non-recurring expense of $2.01 million in merger charges related to the Surrey acquisition. Other increases are attributable to increases in occupancy/furniture and equipment expense, service fees, and amortization of intangibles, and is primarily attributable to the addition of Surrey branches.

Six-Month Comparison. Noninterest expense increased $2.80 million, or 6.15%, for the six months ending June 30, 2024 compared to the same period of 2023. As noted above, noninterest expense for the second quarter of 2024 included a non-recurring charge of $1.80 million to settle a putative class action lawsuit. Noninterest expense for the six month period of 2023 included non-recurring expense of $2.39 million in merger charges related to the Surrey acquisition. Other increases include an increase in salaries and employee benefits, occupancy/furniture and equipment expense, service fees, and amortization of intangibles, and is primarily attributable to the addition of Surrey branches and staff.

Income Tax Expense

The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent differences and available tax credits. Permanent differences are income and expense items excluded by law in the calculation of taxable income. The Company’s most significant permanent differences generally include interest income on municipal securities and increases in the cash surrender value of life insurance policies.

Three-Month Comparison. Income tax expense increased $470 thousand, or 15.37%. The effective tax rate decreased to 21.75% in the second quarter of 2024 from 23.75% in the same quarter of 2023.

Six-Month Comparison. Income tax expense increased $458 thousand, or 6.82%. The effective tax rate decreased to 21.93% for the first six months of 2024 from 23.72% in the same period of 2023.

Non-GAAP Financial Measures

In addition to financial statements prepared in accordance with GAAP, we use certain non-GAAP financial measures that management believes provide investors with important information useful in understanding our operational performance and comparing our financial measures with other financial institutions. The non-GAAP financial measure presented in this report includes net interest income on a FTE basis. We believe FTE basis is the preferred industry measurement of net interest income and provides better comparability between taxable and tax exempt amounts. We use this non-GAAP financial measure to monitor net interest income performance and to manage the composition of our balance sheet. The FTE basis adjusts for the tax benefits of income from certain tax exempt loans and investments using the federal statutory rate of 21%. While we believe certain non-GAAP financial measures enhance understanding of our business and performance, they are supplemental and not a substitute for, or more important than, financial measures prepared on a GAAP basis. Our non-GAAP financial measures may not be comparable to those reported by other financial institutions. The reconciliations of non-GAAP to GAAP measures are presented below.

The following table reconciles net interest income and margin, as presented in our consolidated statements of income, to net interest income on a FTE basis for the periods indicated:

(Amounts in thousands)

(1) FTE basis of 21%.

Financial Condition

Total assets as of June 30, 2024, decreased $35.73 million, or 1.09%, from December 31, 2023. The decrease in assets was primarily driven by decreases in the securities available-for-sale portfolio and loans. Total liabilities decreased $41.32 million, or 1.49%, and was primarily driven by a decrease in deposits. Stockholders' equity increased $5.59 million or 1.11%.

Investment Securities

Our investment securities are used to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral where required. The composition of our investment portfolio changes from time to time as we consider our liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements.

Available-for-sale debt securities as of June 30, 2024, decreased $151.28 million, or 53.84%, compared to December 31, 2023. The decrease is primarily due to the maturity of $141.50 million in U. S. Treasury Notes during the first six months of 2024. The market value of debt securities available-for-sale as a percentage of amortized cost was 89.06% as of June 30, 2024, compared to 95.23% as of December 31, 2023.

Management evaluates securities for impairment where there has been a decline in fair value below the amortized cost basis of a security to determine whether there is a credit loss associated with the decline in fair value on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Credit losses are calculated individually, rather than collectively, using a discounted cash flow method, whereby management compares the present value of expected cash flows with the amortized cost basis of the security. The credit loss component would be recognized through the provision for credit losses and the creation of an allowance for credit losses. Consideration is given to (1) the financial condition and near-term prospects of the issuer including looking at default and delinquency rates, (2) the outlook for receiving the contractual cash flows of the investments, (3) the length of time and the extent to which the fair value has been less than cost, (4) our intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or for a debt security whether it is more-likely-than-not that we will be required to sell the debt security prior to recovering its fair value, (5) the anticipated outlook for changes in the general level of interest rates, (6) credit ratings, (7) third party guarantees, and (8) collateral values. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition, and the issuer’s anticipated ability to pay the contractual cash flows of the investments. U.S. Treasury Securities, Agency-Backed Securities including GNMA, FHLMC, FNMA, FHLB, FFCB and SBA. All of the U.S. Treasury and Agency-Backed Securities have the full faith and credit backing of the United State Government or one of its agencies. Municipal securities and all other securities that do not have a zero expected credit loss are evaluated quarterly to determine whether there is a credit loss associated with a decline in fair value. All debt securities available-for-sale in an unrealized loss position as of June 30, 2024 continue to perform as scheduled and we do not believe that a provision for credit losses is necessary.

Loans Held for Investment

Loans held for investment, which generates the largest component of interest income, are grouped into commercial, consumer real estate, and consumer and other loan segments. Each segment is divided into various loan classes based on collateral or purpose.

The following table presents loans, net of unearned income, with non-covered loans by loan class as of the dates indicated:

(Amounts in thousands)

Total loans as of June 30, 2024, decreased $99.03 million, or 3.85%, compared to December 31, 2023. The largest decrease occurred in the commercial loans segment with an overall decrease of $64.56 million, or 3.89%. Within this segment, the largest decreases occurred in construction and non-farm, non-residential loans with decreases of $24.25 million and $24.04 million, respectively. The consumer real estate segment decreased $21.97 million, or 2.77%, primarily due to a decrease in single family owner occupied of $19.24 million, or 2.76%.

Risk Elements

We seek to mitigate credit risk by following specific underwriting practices and by ongoing monitoring of our loan portfolio. Our underwriting practices include the analysis of borrowers’ prior credit histories, financial statements, tax returns, and cash flow projections; valuation of collateral based on independent appraisers’ reports; and verification of liquid assets. We believe our underwriting criteria are appropriate for the various loan types we offer; however, losses may occur that exceed the reserves established in our allowance for loan losses. We track certain credit quality indicators that include: trends related to the risk rating of commercial loans, the level of classified commercial loans, net charge-offs, nonperforming loans, and general economic conditions. The Company's loan review function performs an independent credit analysis on a risk-based sample of commercial loan relationships annually, and performs a qualitative review of a sample of smaller commercial and retail loans.

Nonperforming assets consist of nonaccrual loans, accrual loans contractually past due 90 days or more, and modified loans past due 90 days or more, and OREO. Ongoing activity in the classification and categories of nonperforming loans include collections on delinquencies, foreclosures, loan restructurings, and movements into or out of the nonperforming classification due to changing economic conditions, borrower financial capacity, or resolution efforts.

The following table presents the components of nonperforming assets and related information as of the periods indicated:

(Amounts in thousands)

Nonperforming assets as of June 30, 2024, increased $282 thousand, or 1.43%, from December 31, 2023. Nonaccrual loans increased $459 thousand, or 2.37%. OREO decreased $92 thousand, or 47.92% and accruing loans past due 90 days or more decreased $85 thousand from year-end. As of June 30, 2024, nonaccrual loans were largely attributed to single family owner occupied (48.58%), non-farm, non-residential (14.13%), and commercial and industrial of (8.57%). Certain loans included in the nonaccrual category have been written down to estimated realizable value or assigned specific reserves in the allowance for loan losses based on management’s estimate of loss at ultimate resolution.

Delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $31.03 million as of June 30, 2024, a decrease of $2.90 million, or 8.54%, compared to $33.93 million as of December 31, 2023. Delinquent loans as a percent of total loans totaled 1.23% as of June 30, 2024, which includes past due loans (0.45%) and nonaccrual loans (0.80%).

When restructuring loans for borrowers experiencing financial difficulty, we generally make concessions in interest rates, loan terms, or amortization terms. Total loans modified as of June 30, 2024, were $2.29 million. As of June 30, 2024, $26 thousand of these loans were 30-89 days past due.

OREO, which is carried at the lesser of estimated net realizable value or cost, decreased $92 thousand, or 47.92%, as of June 30, 2024, compared to December 31, 2023, and consisted of 3 properties with an average holding period of approximately 24 months. The net loss on the sale of OREO totaled $32 thousand for the six months ended June 30, 2024, compared to a net loss of $41 thousand for the same period of the prior year. The following table presents the changes in OREO during the periods indicated:

(Amounts in thousands)

Allowance for Credit Losses

The ACL reflects management’s estimate of losses that will result from the inability of our borrowers to make required loan payments. Management uses a systematic methodology to determine its ACL for loans held for investment and certain off-balance-sheet credit exposures. The ACL is a valuation account that is deducted from the amortized cost basis to present the net amount expected to be collected on the loan portfolio. Management considers the effects of past events, current conditions, and reasonable and supportable forecasts on the collectability of the loan portfolio. The Company’s estimate of its ACL involves a high degree of judgment; therefore, management’s process for determining expected credit losses may result in a range of expected credit losses. It is possible that others, given the same information, may at any point in time reach a different reasonable conclusion. The Company’s ACL recorded in the balance sheet reflects management’s best estimate of expected credit losses. The Company recognizes in net income the amount needed to adjust the ACL for management’s current estimate of expected credit losses. The Company’s measurement of credit losses policy adheres to GAAP as well as interagency guidance. The Company's ACL is calculated using collectively evaluated and individually evaluated loans.

​For collectively evaluated loans, the Company in general uses two modeling approaches to estimate expected credit losses. The Company projects the contractual run-off of its portfolio at the segment level and incorporates a prepayment assumption in order to estimate exposure at default. Financial assets that have been individually evaluated can be returned to a pool for purposes of estimating the expected credit loss insofar as their credit profile improves and that the repayment terms were not considered to be unique to the asset.

In addition to its own loss experience, management also includes peer bank historical loss experience in its assessment of expected credit losses to determine the ACL. The Company utilized call report data to measure historical credit loss experience with similar risk characteristics within the segments. For the majority of segment models for collectively evaluated loans, the Company incorporated at least one macroeconomic driver either using a statistical regression modeling methodology or simple loss rate modeling methodology.

Included in its systematic methodology to determine its ACL for loans held for investment and certain off-balance-sheet credit exposures. Management considers the need to qualitatively adjust expected credit losses for information not already captured in the loss estimation process. These qualitative adjustments either increase or decrease the quantitative model estimation (i.e. formulaic model results). Each period the Company considers qualitative factors that are relevant within the qualitative framework. For further discussion of our Allowance for Credit Losses - See Note 1, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of our 2023 Form 10-K.

As of June 30, 2024, the balance of the ACL for loans was $34.89 million, or 1.41% of total loans. The ACL at June 30, 2024, decreased $1.30 million from the balance of $36.19 million recorded at December 31, 2023. This decrease included a $1.46 million provision offset by net charge-offs for the six months of $2.76 million.

At June 30, 2024, the Company also had an allowance for unfunded commitments of $441 thousand which was recorded in Other Liabilities on the Balance Sheet. During the first six months of 2024, the Company recorded a recovery of provision for credit losses for loan commitments of $305 thousand compared to a recovery of provision of $232 thousand recorded in the same period of 2023.

Deposits

Total deposits as of June 30, 2024, decreased $45.05 million, or 1.65%, compared to December 31, 2023. The largest decreases in deposits occurred in noninterest-bearing demand of $42.46 million, or 4.56%, and interest-bearing demand of $34.99 million, or 5.04%. Time deposits decreased $7.82 million or 3.09%. Theses decreases were offset by an increase in savings of $40.21 million or 4.77%.

Total borrowings in the form of retail repurchase agreements as of June 30, 2024, decreased $225 thousand, or 20.11%, compared to December 31, 2023.

Liquidity and Capital Resources

Liquidity

Liquidity is a measure of our ability to convert assets to cash or raise cash to meet financial obligations. We believe that liquidity management should encompass an overall balance sheet approach that draws together all sources and uses of liquidity. Poor or inadequate liquidity risk management may result in a funding deficit that could have a material impact on our operations. We maintain a liquidity risk management policy and contingency funding policy (“Liquidity Plan”) to detect potential liquidity issues and protect our depositors, creditors, and shareholders. The Liquidity Plan includes various internal and external indicators that are reviewed on a recurring basis by our Asset/Liability Management Committee (“ALCO”) of the Board of Directors. ALCO reviews liquidity risk exposure and policies related to liquidity management; ensures that systems and internal controls are consistent with liquidity policies; and provides accurate reports about liquidity needs, sources, and compliance. The Liquidity Plan involves ongoing monitoring and estimation of potentially credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows during a funding crisis. The liquidity model incorporates various funding crisis scenarios and a specific action plan is formulated, and activated, when a financial shock that affects our normal funding activities is identified. Generally, the plan will reflect a strategy of replacing liability outflows with alternative liabilities, rather than balance sheet asset liquidity, to the extent that significant premiums can be avoided. If alternative liabilities are not available, outflows will be met through liquidation of balance sheet assets, including unpledged securities.

As a financial holding company, the Company’s primary source of liquidity is dividends received from the Bank, which are subject to certain regulatory limitations. Other sources of liquidity include cash, investment securities, and borrowings. As of June 30, 2024, the Company’s cash reserves and short-term investment securities totaled $34.08 million and $10.77 million, respectively. The Company’s cash reserves and investments provide adequate working capital to meet obligations for the next twelve months.

In addition to cash on hand and deposits with other financial institutions, we rely on customer deposits, cash flows from loans and investment securities, and lines of credit from the FHLB and the Federal Reserve Bank (“FRB”) Discount Window to meet potential liquidity demands. These sources of liquidity are immediately available to satisfy deposit withdrawals, customer credit needs, and our operations. Secondary sources of liquidity include approved lines of credit with correspondent banks and unpledged available-for-sale securities. As of June 30, 2024, our unencumbered cash totaled $329.88 million, unused borrowing capacity from the FHLB totaled $391.26 million, available credit from the FRB Discount Window totaled $5.78 million, available lines from correspondent banks totaled $100.00 million, and unpledged available-for-sale securities totaled $106.97 million.

Capital Resources

We are committed to effectively managing our capital to protect our depositors, creditors, and shareholders. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material impact on our operations. Total stockholders’ equity as of June 30, 2024, increased $5.59 million, or 1.11%, to $508.88 million from $503.29 million as of December 31, 2023. Capital increased due to net income of $25.53 million. The increase was offset by dividends declared of $10.68 million as well as the repurchase of our common stock totaling $8.25 million. Book value per share at June 30, 2024, was $27.85, an increase of $0.65 from year-end 2023.

Capital Adequacy Requirements

Risk-based capital guidelines, issued by state and federal banking agencies, include balance sheet assets and off-balance sheet arrangements weighted by the risks inherent in the specific asset type. Our current risk-based capital requirements are based on the international capital standards known as Basel III. A description of the Basel III capital rules is included in Part I, Item 1 of the 2023 Form 10-K. Our current required capital ratios are as follows:

• 4.5% Common Equity Tier 1 capital to risk-weighted assets (effectively 7.00% including the capital conservation buffer)
• 6.0% Tier 1 capital to risk-weighted assets (effectively 8.50% including the capital conservation buffer)
• 8.0% Total capital to risk-weighted assets (effectively 10.50% including the capital conservation buffer)
• 4.0% Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”)

The following table presents our capital ratios as of the dates indicated:

Our risk-based capital ratios as of June 30, 2024, increased from December 31, 2023, primarily due to a decrease in risk weighted assets. The decrease in risk-weighted assets was primarily driven by a decrease in both the loan and securities available for sale portfolios. As of June 30, 2024, we continued to meet all capital adequacy requirements and were classified as well-capitalized under the regulatory framework for prompt corrective action. Management believes there have been no conditions or events that would change the Bank’s classification. Additionally, our capital ratios were in excess of the minimum standards under the Basel III capital rules as of June 30, 2024.

Off-Balance Sheet Arrangements

We extend contractual commitments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is the same as the contractual amount of the instrument. The following table presents our off-balance sheet arrangements as of the dates indicated:

(Amounts in thousands)

(1) Includes FHLB letters of credit

Market Risk and Interest Rate Sensitivity

Market risk represents the risk of loss due to adverse changes in current and future cash flows, fair values, earnings, or capital due to movements in interest rates and other factors. Our profitability is largely dependent upon net interest income, which is subject to variation due to changes in the interest rate environment and unbalanced repricing opportunities. We are subject to interest rate risk when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. ALCO reviews our mix of assets and liabilities with the goal of limiting exposure to interest rate risk, ensuring adequate liquidity, and coordinating sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment. ALCO is also responsible for overseeing the formulation and implementation of policies and strategies to improve balance sheet positioning and mitigate the effect of interest rate changes.

In order to manage our exposure to interest rate risk, we periodically review internal simulation and third-party models that project net interest income at risk, which measures the impact of different interest rate scenarios on net interest income, and the economic value of equity at risk, which measures potential long-term risk in the balance sheet by valuing our assets and liabilities at fair value under different interest rate scenarios. Simulation results show the existence and severity of interest rate risk in each scenario based on our current balance sheet position, assumptions about changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and estimated yields earned on assets and rates paid on liabilities. The simulation model provides the best tool available to us and the industry for managing interest rate risk; however, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income due to the use of significant estimates and assumptions. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in our strategies that management might undertake in response to a sudden and sustained rate shock.

As of June 30, 2024, the Federal Open Market Committee had set the benchmark federal funds rate to a range of 525 to 550 basis points. The following table presents the sensitivity of net interest income from immediate and sustained rate shocks in various interest rate scenarios over a twelve-month period for the periods indicated:

(Dollars in thousands)

Inflation and Changing Prices

Our consolidated financial statements and related notes are presented in accordance with GAAP, which requires the measurement of results of operations and financial position in historical dollars. Inflation may cause a rise in price levels and changes in the relative purchasing power of money. These inflationary effects are not reflected in historical dollar measurements. The primary effect of inflation on our operations is increased operating costs. In management’s opinion, interest rates have a greater impact on our financial performance than inflation. Interest rates do not necessarily fluctuate in the same direction, or to the same extent, as the price of goods and services; therefore, the effect of inflation on businesses with large investments in property, plant, and inventory is generally more significant than the effect on financial institutions.

Astronomic federal government spending, growth in economic activity and demand for goods and services, alongside labor shortages and supply chain complications, have contributed to rising inflation. In response, the Federal Reserve Bank has begun raising interest rates and signaled that it will continue to raise rates, taper its purchase of mortgage and other bonds and reduce the size of the balance sheet over time. The timing and impact of inflation and rising interest rates on our business and related financial results will depend on future developments, which are highly uncertain and difficult to predict.

Most LIBOR settings ceased to be published after June 30, 2023. The Company had discontinued originating LIBOR-based variable rate loans in 2018 in favor of U. S. Treasury rates. The Company has substituted an alternative reference rate published by the U. S. Treasury for any remaining loans tied to LIBOR.

The information required in this item is incorporated by reference to “Market Risk and Interest Rate Sensitivity” in Item 2 of this Quarterly Report on Form 10-Q.

Evaluation of Disclosure Controls and Procedures

In connection with this report, we conducted an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures under the Exchange Act Rule 13a-15(b). Based upon that evaluation, the CEO and CFO concluded that, as of June 30, 2024, our disclosure controls and procedures were effective.

Disclosure controls and procedures are our Company’s controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions about required disclosure.

Management, including the CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or management’s override of the controls.

Changes in Internal Control over Financial Reporting

We assess the adequacy of our internal control over financial reporting quarterly and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2024, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2023, discuss potential events, trends, or other circumstances that could adversely affect our business, financial condition, results of operations, cash flows, liquidity, access to capital resources, and, consequently, cause the market value of our common stock to decline. These risks could cause our future results to differ materially from historical results and expectations of future financial performance. If any of the risks occur and the market price of our common stock declines significantly, individuals may lose all, or part, of their investment in our Company. Individuals should carefully consider our risk factors and information included in our annual report on Form 10-K for the year ended December 31, 2023 before making an investment decision. There may be risks and uncertainties that we have not identified or that we have deemed immaterial that could adversely affect our business; therefore, such risk factors are not intended to be an exhaustive list of all risks we face. There have been no material changes to the risk factors included in Part I, Item 1A, “Risk Factors,” of our annual report on Form 10-K for the year ended December 31, 2023.